This market has definitely been challenging lately. One day, stocks rally on hopes that the Fed might lower interest rates in December, and the next day, worries about a potential AI bubble drag them down. It’s not surprising that the CBOE Volatility Index (VIX), often called the “fear index,” spiked in November, hitting the highest point since Trump’s “Emancipation Day” back in April. Naturally, there are always down days, but it’s particularly frustrating when the numbers don’t back the market’s movements. To put it into perspective, 83% of S&P 500 companies reporting earnings so far have surpassed estimates, while 76% are coming off strong quarters. Yet, this success hasn’t prevented relentless selling, affecting even the top performers. This behavior can be annoying, sure, but it also opens doors for savvy investors who know where to look and how to adjust their strategies.
To assist you in navigating these turbulent times, here are six questions to ponder. Your responses can guide whether to protect your current stocks, keep your exposure as is, or perhaps buy more.
1. Have any changes occurred in the company or industry that might influence future earnings? We’re all about the fundamentals here. Ultimately, we’re more concerned about a company’s financial health and earning potential than we are about its stock price. It’s not always a straightforward task, though. Price movements can reveal gains or losses on any given day. But if you’re a long-term investor, keeping your eyes on future profitability is key. As the legendary investor Benjamin Graham once said, “In the short term, the stock market is a voting machine.” Over time, stock prices often reflect company performance. If your investment thesis seems shaky, you might reconsider sticking to it. Sometimes, bad news is already factored in, causing stock prices to overreact. That said, one negative update shouldn’t automatically trigger a sale. But it does warrant a thoughtful reassessment of whether you want to stay invested. Conversely, if after evaluating both the company’s specifics and external factors like regulatory changes, you feel confident in the long-term earnings potential, a dip in stock price could be a buying opportunity.
2. From a macroeconomic standpoint, have there been any shifts that might alter investors’ willingness to pay for the company’s earnings? This first question focuses on earning capacity, but that’s just one aspect of determining stock value. You also need a broader perspective. Consider how global events or changes in monetary and fiscal policy might shape the economic landscape. This helps you understand how these shifts could impact sentiment and the way investors value company earnings. For instance, if inflation expectations rise, prompting the Fed to maintain or halt rate cuts, we might anticipate reducing multiples on earnings estimates, or increasing the discount rate on future earnings. This broader analysis aids in setting a price target for a stock. The target price often comes down to earnings per share multiplied by how many investors are interested in those earnings.
3. What does the multiple look like compared to both the stock’s historical valuation and the broader market? Once you grasp whether the multiple should broaden, contract, or stabilize based on that top-down view, it’s important to see how that relates historically to the market. You need to establish a reference point, typically the multiple the stock has traded at in the past. Don’t overlook growth rates and shifts in investor sentiment, as they can skew valuations. This question aims to refine your price target and enhance your perspective based on historical valuation dynamics. It’s crucial to grasp how the narrative has evolved over time to assess whether investors should be willing to pay more or less in light of current circumstances. Take Wells Fargo as an example; we suggested that its multiple could rise post-regulatory milestones. That’s promising, but by how much? It’s often more useful to look at pricing of other well-performing banks, such as JPMorgan, which could serve as a benchmark.
4. What insights can you draw from the chart? After establishing a potential buy level, consider various technical analysis tools to identify potential support levels. I prefer a straightforward approach, often favoring essential indicators rather than intricate methods. Check where the 50-day and 200-day moving averages converge, along with long-term trend lines and support levels. Volume is another critical factor; higher volume suggests that price movements carry more weight due to increased participation. Tools like the Relative Strength Index can also help indicate if a stock is oversold or overbought. If the chart suggests some support has historically attracted buyers, it may be a good time to buy. Conversely, if long-term support breaks down, it might be wise to hold off, as the stock could be in a dangerous downward trend.
5. What’s your current position? With a potential entry level in mind, decide how much of your portfolio you’re comfortable allocating. Think in terms of percentage weightings. For instance, a full position might be around 5% to 6%, meaning if your weight is already at 5%, it’s probably not the best time to add more. Your approach will depend on your total investment and how substantial your existing positions are. If your current stake is minor, you might want to act more decisively, knowing there’s room to absorb further weakness. However, for larger positions, it might be wise to wait for a more significant drop to make a more impactful purchase.
6. Are any upcoming events on the horizon that could serve as catalysts? Finally, consider future developments before executing a trade. Look at expected updates and how they could shift your investment thesis. Certain triggers, like forthcoming economic indicators or resolutions of legal matters, might have a more considerable impact than others. For instance, quarterly results can be particularly unpredictable, and even if you analyze the key figures accurately, predicting how investors will respond is another story altogether. A case in point is Nvidia, which faced a downturn following a less-than-ideal quarter.
Keep these questions in mind as you navigate this complex environment. They can help clarify your strategy and enhance your decision-making processes during these uncertain times.
